Question

2. Money supply, money demand, and adjustment to monetary equilibrium The following table shows a money demand schedule, which is the quantity of money demanded at various price levels (P Fill in the Value of Money column in the following table. Price Level (P) 0.80 1.00 1.33 Quantity of Money Demanded Billions of dollars) 2.0 2.5 4.0 8.0 Value of Money (1/P) Now consider the relationship between the price level and the quantity of money that people demand. The lower the price level, the the typical transaction requires, and the money money people will wish to hold in the form of currency or demand deposits Assume that the Fed initially fixes the quantity of money supplied at $4 billion.

Answer 1

(1)

Price Level (P)	Value of money = 1/P	Quantity of Money demanded ($ Billion)
0.8	= 1/0.8 = 1.25	2
1	= 1/1 = 1	2.5
1.33	= 1/1.33 = 0.75	4
2	= 1/2 = 0.5	8

(b) The lower the price level, the lower the amount of money a typical transaction requires, and the lower the amount of money people will wish to hold.

(c) MS1 and money demand curve are as follows.

2.00 1.75 MS 1.50 Lu 125 Maney Demand L1.00 0.75 id MS 2 050 025 3 5 6 QUANTITY OF MONEY (Bilions of dolars)

(d) Equilibrium value of money (corresponding to intersection point of MS1 and MD) is 0.75, and equilibrium price level is 1.33.

(e) To reduce money supply, Fed uses open market operations to sell government bonds to public.

(f) MS2 is shown in above graph.

(g) Quantity of money supplied is now less than the quantity of money demanded. This expansion will decrease people's demand for goods and services. In long run, price of goods and services will decrease & value of money will increase.